Competition for infrastructure assets is set to intensify over the next 12 months, as it provides investors with the combination of stable yield and strong potential for capital growth – an attractive proposition for those seeking yield in a low-growth environment. In this article, we explore the growth potential of infrastructure and four of the key reasons to invest in this asset class.
Essential services provided by the core industry sectors of water, transport, energy and communication generate the unique cash flow distinctive to infrastructure investments. Due to the ongoing requirement of these assets, their manageable risks, hedge against inflation and tendency to enhance portfolio performance, the income they generate is attractive to investors and often available at a steady rate for a long period of time.
Four key reasons to invest:
1. Ongoing requirement for the asset class
The need for infrastructure investment is dominated by the core industry sectors of water, energy, transport and communication – it is the backbone for economies to develop and remain competitive. An estimated US $78 trillion will be required for global infrastructure investment over the next two decades.1
Investment in infrastructure helps stimulate sustainable long-term economic growth which then creates a further need for infrastructure. Ultimately, it promotes higher living standards as it fosters economic growth and promotes jobs. The future growth in infrastructure will not only be driven by the need for new infrastructure, particularly in developing economies, but also by the need to replace existing infrastructure.
2. Manageable risks
Governments and regulators are complicit in reducing risks – including inflation, interest rates, economic growth, commodity price risk and competition – with the expectations of lowering the cost of capital for investment. This could mean a lower final tariff for the consumer or a higher selling price if the asset is being sold or leased to the private sector.
Lower returns can be positive for infrastructure companies, provided that the return is offset by the reduction in risk and that the asset maintains attractive risk adjusted returns to promote continued investing. Reducing risks also allows the infrastructure company to focus more on the operations of the asset in order to provide a higher quality of service to consumers/users.
Global listed infrastructure companies in particular are focussed on reducing their risk to interest rates, inflation, commodity prices and volume. As well as improving the stability, reliability and growth of cash flows generated by infrastructure assets, managing risks have proved to lead to greater risk-adjusted returns as reflected by share price performance.
3. Hedge against inflation
Limited sensitivity to inflation is a characteristic commonly associated with infrastructure companies. A level of protection from inflation is generally the case, but it is important to understand the nuances in different regulatory and contract frameworks, and critically, those that don’t include the pass-through.
Transurban is a good example of the inflation pass-through mechanism. Each of their 10 Australian toll roads located in Melbourne, Sydney and Brisbane see their tolls increased annually with inflation. However, the rate of inflation used and increment of the increase differs from road to road. This has varying impacts on the cash flows, albeit these are minimal in a diversified portfolio. The effect of these contract terms is that almost 100% of the cash flows from the Australian operations are protected from rises in inflation.
Infrastructure assets also tend to have long-term debt structures, with a large portion of this debt at a fixed interest rate. Therefore, interest payments are not sensitive to fluctuating central bank rates.
4. Enhancing portfolio performance
Regulatory and contract frameworks provide significant cash flow generation from the underlying assets. While an amount of this cash flow will be reinvested, due to the demanding investment requirements, there is still ample opportunity for infrastructure companies to pay attractive dividends to their shareholders. The level of these dividends, the yield, compares favourably to bonds and global equities. In addition, the dividends are seeing good growth – often well above inflation – from the cash flow growth that comes from companies continuing to invest and earning returns above their cost of capital.
Infrastructure shares may also provide high yields in comparison to cash – infrastructure companies generate very stable cash flow each year and this allows them to pay out high and growing dividend payments to shareholders.
Final thoughts
The infrastructure market is expected to grow significantly as a proportion of investable assets in global capital markets during the next 15 years.
While some large cap unlisted trophy assets have attracted very high prices, there still appears to be value in most mid cap and niche infrastructure assets.
Stable, reliable, growing cash flows are unique characteristics to the global listed infrastructure asset class and contribute to attractive risk-adjusted returns. However, recognition of these attributes is still low and the asset class remains at the early stages of its development, suggesting that now is an ideal time to make an allocation to global listed infrastructure.
1PwC, 2014. Capital Project and Infrastructure Spending.
Source: AMP Capital
About the Author
Tim Humphreys,
Head of Global Listed Infrastructure
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.